Markets

Bond Yields Decline Again

The rally in U.S. government debt just keeps going and going and going....

On Wednesday, yields on U.S. Treasuries fell for a third straight day as investors speculated that rising worker productivity will keep inflation in check, giving the Federal Reserve room to follow Tuesday's interest rate cut with another in December.

Productivity gains and lower labor costs "indicate there's the possibility for growth, so we can keep lowering short-term interest rates without worrying about inflation," said James Cusser, who manages about $1 billion at Waddell & Reed in Overland Park, Kan. The Commerce Department reported Wednesday that U.S. worker productivity rose at a 2.7% annual rate in the third quarter, the fastest pace in more than a year.

The yield on the benchmark 10-year note fell to 4.18% from Tuesday's close of 4.25%. It was the lowest close for the 10-year note--a key indicator of rates on home mortgages--since October 1998. The yield on the two-year note fell to 2.29% from 2.33%. Bond yields have been plummeting since last week, when the Treasury announced it would stop selling 30-year bonds. The rally continued this week when the Fed cut interest rates for the 10th time this year, and was gaining strength even before the release of Wednesday's economic news because of speculation the Fed will cut its target interest rate again in December.

The Fed trimmed the rate for overnight loans between banks--known as the federal funds rate--half a percentage point Tuesday to a 40-year low of 2% in a bid to foster economic growth. In a statement accompanying the cut, the Fed said, "The risks are weighted mainly toward conditions that may generate economic weakness."

"There's follow-though buying from [Tuesday] on the realization that the Fed has more to do," said Kevin Logan, chief market economist at Dresdner Kleinwort Wasserstein. "The Fed is telling us the economy is weak, and the data tell us the economy is weak."

Gains in Treasuries were limited by the government's auction of$7 billion of 10-year notes, which added to the supply of the securities. The government sold the notes to yield 4.22%. It was the second sale in two days, following a $16-billion auction of five-year notes, the largest issue of securities of that maturity since November 1998.

A $1-billion sale of 10-year notes by Verizon Communications (ticker symbol: VZ), the biggest U.S. local telephone company, also slowed gains in Treasuries as some investors earmarked money for the higher-yielding corporate debt. The Verizon notes will be priced to yield 1.55 percentage points more than Treasuries, according to people familiar with the sale.

Thirty-two of 42 economists surveyed by Bloomberg News forecast a rate cut of at least a quarter-point at the Fed's Dec. 11 meeting as policymakers try to reverse a slump that led to a 0.4% contraction in the economy in the third quarter. The other 10 economists said the Fed will hold rates steady.

"We're in a significant decline in economic growth, and this last quarter will probably surprise to the downside," said Chris Sullivan, who manages $650 million at the United Nations Federal Credit Union. "The Fed will be on track" for more rate reductions.